Question

Lillian Crisp incorporated NutriCrisp two years ago, hoping to eventually tap into the lucrative health cereal market. Located in southwestern Ontario, NutriCrisp Inc. has yet to start selling any cereal, but Lillian has completed test production and researched the cereal industry. Lillian has taken her grandmother's secret recipe for all-natural cereals and has developed three varieties: banana/chocolate/oat, strawberry/cream/nut, and papaya/plum/wheat bran. All cereals will be manufactured in a similar way, will use the same production facilities, and will have almost identical cost structures. Recognizing that she doesn't have an adequate background in accounting, Lillian has hired you to help her. The data she collected are in Exhibit 1. Required In a report to Lillian, use the data that she has collected and calculate her anticipated break-even point. In addition, Lillian would like you to address any factors that may impact your calculations and provide details that support your calculations and assumptions. In this report, you should evaluate the information she has provided you with and address any concerns you may have, including marketing or strategic concerns. » » EXHIBIT 1 - INFORMATION COLLECTED BY LILLIAN The Canadian cereal market is a multi-billion-dollar industry, with average annual revenues approx- imating $456 million. Smaller companies tend to be more profitable than larger companies. Lillian expects to lease space at a manufacturing facility for $10,000 per month. This includes the use of its machinery for production. The cost of the raw materials is the most expensive part of the manufacturing process. Lillian estimates that each box will result in raw material costs of $1.45 (including packaging). This is higher than the industry average but is the result of the low production volume she is estimating, and the higher quality of ingredients being used in the cereal. Lillian is estimating that her fixed administrative expenses will approximate $120,000 annually, excluding any salary she would pay herself. Production labour is considered variable in this industry and is estimated at $0.50 per box. Lillian is targeting health food stores and upscale grocery stores and is expecting to charge the stores $4.20 per box with a target retail price to consumers of $4.99. At a minimum, Lillian believes she can sell about 5,500 boxes per month in her first three months, and then about 8,500 boxes per month thereafter. Based on her research, she believes that she can actually sell 7,000 per month in her first three months, and then 11,000 boxes per month thereafter. If her cereal takes off quickly, a lofty but not unrealistic target would be monthly sales of 19,000 boxes. Lillian would like an after-tax target profit for NutriCrisp of $60,000 as this would allow her to pay herself a small salary. You are assuming a tax rate of 30% in your calculations. >> »

Answer 1

Calculation of the anticipated Break-even point
Break-even sales volume p.m.(for after-tax target profit of $ 60000)
Price/box charged to stores	4.2
Less: Variable costs/box
Raw material incl.packaging	1.45
Production Labor	0.5
Total variable costs /box	1.95
Contribution/box (4.2-1.95)	2.25
Fixed administrative expenses	120000
Lease cost of mfg. facility(10000*12)	120000
Total fixed costs p.a.	240000
Target After-tax profit	60000
so, Target Before-tax profit=(60000/(1-30%))*100%	85714
So,Break-even sales boxes
(Fixed costs+Before-tax target profit)Contribution per unit
(240000+85714)/2.25=	144762
boxes p.a.
Break-even sales volume p.m.=	144762/12=
boxes Per mth.	12064
Breakeven sales $ p.a.	144762*4.2=
	608000
Breakeven sales $ p.m	50667
Normal Break-even point(No Loss No gain)
The break-even sales units= Fixed costs/Contn.per unit
ie. 240000/2.25=
106667 boxes p.a. & 106667/12= 8889 boxes p.m.
is. $ 448001 p.a. OR $ 37334 p.m.
If she aims a target after-tax profit of $ 60000 , the target sales volume need to be 12064 boxes p.m.(ie.144762 boxes p.a.) at this price & variable and fixed costs.
She needs to aim sales at the break-even point (no loss no gain) initially , as that level itsef (8889 boxes p.m.) is some way to go ,and try to increase sales volume , by adopting more cost-effective marketing strategies.